Have you ever wondered why so many people are obsessed with making money on the stock market or other similar investments? This is due to an investor's treasure known as compound interest.
If you want to discover this treasure, you should familiarize yourself with the power of the compound compound interest or compound interest.
Compound interest and compound interest can cause your money to grow beyond any amount you could ever hope for. Here's how.
The miracle of compound interest and its idea, compound interest
Albert Einstein was assigned the term compound interest as "the greatest mathematical discovery of all time". And he's absolutely right when it comes to practical applications; especially in terms of your finances.
Compound interest is a phenomenon that occurs when the returns on your investments are combined with your original investments (referred to as capital) to generate ever greater returns over time.
As you will see in the following example, the profit growth eventually becomes so large that it exceeds the original main contributions and starts to explode at an extraordinary speed.
This is why successful investors say the first $ 100,000 is the hardest to invest. After you save and earn interest on your first $ 100,000, compound interest will make your money grow MUCH faster.
what does that mean to you? Accumulation of income (i.e. MORE MONEY) – with little to no work on your part.
Compound interest: the 8th wonder of the world
Compound interest is a financial advantage that you absolutely want to have in your passive income portfolio. Albert Einstein called it the eighth wonder of the world.
Compound interest income offers you a unique opportunity, because once your portfolio has reached a certain threshold, you can theoretically live on the remaining income that your money earns each year – indefinitely.
Unlike some other passive income building strategies, if you choose a good investment like a stock market index fund, it can be a 100% passive process to live off the returns on your investments.
2 options – which one earns more money?
To really illustrate the benefits of compound interest, I would like to ask you a question first. How much money would you make if you invested $ 10,000 a year for 40 years using one of two investment options:
A) Under your mattress?
B) In a stock market index fund?
The second option results in almost 6.5 times more money than the first? Why is that? That is the beauty of a continuous compound interest over time.
This can result in ridiculously more money being spent over longer and longer periods.
A closer look at how compound interest works continuously:
To understand how we managed to get such a large number that uses the power of compound interest, let's analyze this process a little bit to see how it works and benefits our efforts to get rich.
Option A is easy to understand. You just take $ 10,000 a year and literally put it under your mattress (just like you did during the Great Depression).
Since your investment earns absolutely no interest (since your mattress is not the same as the bank and does not pay you any interest), the math for this scenario is very easy to understand:
- 10,000 x 40 years = $ 400,000
Even if you've seen this mathematically, the truth is that your money would be even less worth it. This is due to the inflation losses during this period.
According to the rule of 72 and an inflation rate of 3%, your money would be worth half as much after 72/3 = 24 years. After about 40 years, the money you chose to be "safe" by tucking it under a mattress would be worth about a quarter of the purchasing power it has today! Yikes!
This is a great success for your portfolio!
Option B is best understood through an illustrative process.
For the sake of simplicity, let's assume in this example that your investment earns just 8% each year. (Of course, this never really happens in reality, but it will show how compound interest works in this lesson).
The average return on the S & P 500 from 1957 to 2018 is 8%. Okay, for example.
At the beginning of the first year, we invest $ 10,000 and earn no interest.
At the end of the second year, we're investing another $ 10,000 in a total of $ 20,000. The 8% return on our $ 10,000 is $ 800 (red). This adds to our main investment (blue).
Now continue this process for another 3 years and we come to the end of the 5th year. We have invested $ 50,000 (5 x $ 10,000) and the return on investment has increased to $ 8,666 ($ 800 + $ 2,464 + $ 5,061).
Notice how as our overall portfolio increases, so does our return on this investment.
Now fast forward to the end of 20 years. Now the amount of money we make from our total investment (red) actually exceeds the total amount we originally invested each year (blue).
By the end of the 40th year, the power of continuous compound interest had meant that returns actually contributed more to the overall portfolio than we originally invested in the portfolio.
IMPRESSIVE! This is damn amazing, don't you agree?
How does this lead to a high passive income?
How does a portfolio of almost $ 2.6 million help you financially? How about if you could passively live on just over $ 100,000 a year?
Most people could easily live on $ 100,000 a year – a life that is pretty well lived, I could add.
If you follow the traditional financial planning proposal to apply the 4 percent retirement payout rule, you can allow yourself to take 4% out of your portfolio each year (and then adjust inflation each year).
Passive income of $ 100,000 a year is no small feat!
In contrast, how much money could you withdraw each year using the “under the mattress” saving technology? $ 16,000 a year – a number that qualifies you for poverty. Which option would you prefer to go?
Smart investors always use compound interest
Every successful investor, from Warren Buffett to Peter Lynch to John Bogle, is heavily dependent on the power of compound interest.
The successful investor knows that this type of passive interest income is the key to maximum asset growth.
For this reason, intelligent financial planners almost always recommend starting retirement savings early and investing as much as you can afford.
How you invest is also important
Keep in mind that how you invest is important. Almost every investment involves a certain risk. However, successful investors do not take unnecessary risks.
For example, smart investors often invest in blue chip stocks that pay dividends. Blue chip shares are shares of proven companies with a long history of success and sustainability.
Think of Coca Cola, 3M, Walmart, Johnson & Johnson, McDonalds, etc. It's not that these companies can't lose money.
But they have proven over time that they have solid staying power.
While smart investors choose investments that grow slowly and steadily over time, they stay away from riskier investment options such as day trading, where very few investors make money.
The percentage of investors who make decent money with riskier options like day trading is incredibly low compared to those who seek smaller but more stable returns.
Do some research
As someone who is looking for passive income through investment, it is vital to continue training. Read books by experts like John C. Bogle who share tips and secrets to invest.
Use their successes – and failures – to get more information to help you make investment decisions that work for you.
The better your investments do, the more compound interest you earn.
Here are some ideas you might want to consider if you want compound interest to grow your money faster.
* Note that all investments listed here – and all investments in general – have the potential to lose money.
1. Invest in dividend stocks
Dividend-paying stocks are stocks that pay you money just to hold stocks. Every quarter or so (depending on the stock) you get a small percentage of the value of your stock as a kind of cash bonus.
Some people take this cash bonus as a passive source of income to pay the bills. If you've invested enough money, you may be able to live off your dividend income.
However, if you don't need the income, you should reinvest your dividend payments so your shares can earn more compound interest.
By reinvesting your dividend payment, your portfolio balance grows even faster.
2. Invest in peer-to-peer loans
Peer-to-peer loans are loans to borrowers, and borrowers pay you the interest on the loan rather than paying the banks the interest they pay.
The Lending Club is an example of a company that offers peer-to-peer loans to investors. As an investor, you will be shown a list of the loans that potential borrowers are asking about.
You can view all loan factors, e.g. B. the amount requested, the interest rate, the term and the grade of the loan. The grade reflects the borrower's credit rating.
Then choose which loans you want to finance and how much of the loan you want to finance.
If the loan is repaid, you will be repaid with interest. And you can reinvest these funds to earn more interest.
It is really a revolutionary way to invest your money. Why should banks have all the fun when you can take some of the profits for yourself?
3. Invest in real estate (affordable)
Traditional real estate investments can be profitable but also costly. However, there are several companies that offer crowdfunded real estate investment options.
In other words, they buy real estate investment property (commercial and residential) with money from a pool of investors. If the investments are profitable, investors receive part of that profit.
And like other types of investments, depending on the investment company model, you can take your profits in cash or reinvest in your funds.
For example, companies like Fundrise invest in commercial and residential properties. You use crowdfunding funds from investors like you and me.
Then the profits are shared with the investors. You can invest with Fundrise for just $ 500, making it affordable for almost everyone.
As you can see, there are several ways to earn more compound interest on your investments.
4. Invest in a mutual fund with a good track record
Some investors simply invest in mutual funds or pension funds with an excellent track record. One such popular fund is the Vanguard Total Stock Market Index Fund (VTSAX).
This fund was founded in 1992 and has an average return of over 10% for ten years. Fees are also low, which is another reason why it is popular with investors.
The mutual fund you invest in depends on your risk tolerance and other factors. You can find more information about the investment in popular investment books such as The Intelligent Investor by Benjamin Graham.
While good mutual funds generally generate consistently positive returns over time, as with any investment, it is possible to lose money when investing in mutual funds.
That is why it is so important to research and select the right investment in mutual funds.
The strong results of compound interest and returns can help you expand your portfolio many times over than you could without it.
An essential part of determining the best passive sources of income for yourself is seriously considering compound interest. Personally, I use it as the main source of my passive income portfolio.
My crowdfunded real estate account at Rich Uncles is one of my top performing passive income accounts. And compound interest (since I am currently reinvesting my dividends) is a big part of this performance success.
Use compound interest for your passive income portfolio. Use it to make a lot more money that you can passively live on.
Are you using the miracle of compound interest to increase your personal wealth?